2018 Federal Reporting Requirements. for Episcopal Churches. Publish date: January 31, Prepared by Richard R. Hammar, J.D., LL.M.

Transcription

1 2018 Federal Reporting Requirements for Episcopal Churches Prepared by Richard R. Hammar, J.D., LL.M., CPA Publish date: January 31, 2018 Editors: The Reverend Canon William F. Geisler, CPA (ret.) Nancy N. Fritschner, CPA Laurence Dresner, ChFC

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3 Mary Kate Wold CEO and President 19 East 34th Street New York, NY (800) In keeping with The Church Pension Fund s ongoing commitment to conserving our natural and financial resources, this year the 2018 Federal Reporting Requirements for Episcopal Churches is being offered exclusively as an online booklet. The 2018 Clergy Tax Guide also is being disseminated online. To access that document, please go to Faithfully, Mary Kate Wold CEO and President

4 Table of Contents Introduction... 1 Medical Insurance Reimbursement Plan/ Employer Payment Plan Internal Revenue Code Section st Century Cures Act Special HRA Rules for Small Employers...3 Reporting the Value of Health Care Coverage Provided to Non-Dependent Domestic Partners and Their Children and Employees Adult Children Age 26 or Older...4 Reporting Requirements for 2017 Calendar Year: Employer-Provided Health Insurance Offer and Coverage...4 Maximizing Tax Benefits for Your Minister... 5 Special Notes for New Clergy...5 Special Notes for Churches Pertaining to Current Employees...6 Housing Allowance...8 Sample Housing Allowance Resolution for Minister Who Owns His/Her Home Sample Housing Allowance Resolution for Minister in Church-Provided Rectory Accountable Reimbursements Qualified Transportation Fringe Benefits Flexible Spending Accounts Health Flexible Spending Accounts Dependent Care Flexible Spending Accounts Section 403(b) Plans Complying with Federal Payroll Tax Reporting Obligations...17 Step 1. Employer Identification Number (EIN)... 17

5 Step 2. Employee or self-employed? Step 3. Social Security number of each worker Step 4. Complete a Form W Step 5. Compute taxable wages Step 6. Determine the amount of income tax to withhold Step 7. Withhold Social Security and Medicare taxes from non-ordained employees wages Step 8. Church must deposit the taxes it withholds Step 9. Filing Form 941 quarterly Step 10. Prepare Form W Step 11. Prepare Form 1099-MISC Other Important Requirements for Churches Reporting Group Term Life Insurance...34 New Hire Report...35 Form I Annual Certification of Racial Non-Discrimination...36 Charitable Contribution Substantiation Rules...38 Sample Form W Helpful Numbers and Resources...43

6 Introduction The most important federal reporting obligation for most churches is the withholding and reporting of employee income taxes and Social Security and Medicare taxes. These payroll reporting requirements apply, in whole or in part, to almost every church. Note: The term church is used broadly throughout this publication and refers to actions taken by the vestry and/or the congregation, depending on the nature of the action. This may include entities that are controlled by or associated with the Episcopal Church. Many of the reporting obligations covered in Federal Reporting Requirements for Episcopal Churches can be met by using a payroll services provider. Warning Federal law specifies that any corporate officer, director, or employee who is responsible for withholding taxes and paying them to the government may be liable for a penalty in the amount of 100% of such taxes if they are either not withheld or not remitted to the government. This penalty is of special relevance to church leaders, given the high rate of non-compliance by churches with payroll reporting procedures. A number of special rules apply to churches: A definition of minister for IRS tax purposes. Key Point The IRS has its own criteria for determining who is a minister for tax purposes. In the Episcopal Church, only bishops, priests, and deacons (ordained ministers as opposed to lay ministers), regardless of the responsibilities of the work done for the church, meet the criteria for the IRS designation of minister. Whether or not one qualifies as a minister for tax purposes is a very important question, since special tax and reporting rules apply to ministers under federal income tax law. These rules include: 1. Eligibility for housing allowances 2. Self-employed status for Social Security and Medicare tax purposes 3. Exemption of federal and state wages from income tax withholding (ministers must use the quarterly estimated tax procedure to pay their taxes, unless they elect voluntary withholding). If ministers elect voluntary withholding, they should withhold sufficient taxes to cover both federal income taxes and self-employment taxes. 1 The 2018 Federal Reporting Requirements for Episcopal Churches

7 These special rules apply only with respect to compensation for services performed in the exercise of ministry. The approval of an Extension of Ministry under The Church Pension Fund Clergy Pension Plan (Clergy Pension Plan) does not automatically qualify a cleric for clergy tax treatment. If the cleric does not qualify for clergy tax treatment, he or she will be treated as a lay person for payroll tax purposes and will not be eligible for the housing allowance exclusion. Work performed directly for the Church is considered exercise of ministry, no matter the nature of the work. Generally, work for non-church organizations must be primarily sacerdotal to qualify for the housing allowance and the cleric must be assigned to the position by the Bishop. Example John is a minister at his church. In addition, he works a second job as a counselor for a school district. Assume that John qualifies as a minister for federal income tax purposes. Since his church duties constitute services performed in the exercise of ministry, the church can designate a housing allowance for him. However, the secular employer cannot designate any portion of John s compensation as a housing allowance, since this work would not be service in the exercise of ministry. 1. Ministers are always self-employed for Social Security and Medicare tax purposes with respect to their church compensation. While most clergy are employees for federal income tax reporting purposes, they are self-employed for Social Security and Medicare tax purposes with respect to their church compensation. This means that they pay the self-employment tax (SECA) rather than the employee s share of Social Security and Medicare taxes. As such, the church should not withhold the employee s share of Social Security and Medicare taxes from their wages. There is much confusion regarding this issue. Most Episcopal ministers with continuing relationships with their employers are considered employees for federal income tax purposes under the tests currently used by the IRS and the courts, and should receive IRS Form W-2 from their churches or employers reporting their taxable incomes. This statement applies to part-time as well as full-time employees. However, all ministers are self-employed for Social Security and Medicare tax purposes (with respect to services they perform in the exercise of their ministry). 2. A minister s wages are exempt from compulsory income tax withholding, whether the minister reports his or her income taxes as an employee or as self-employed. Clergy may enter into a voluntary withholding agreement with their employing church. The 2018 Federal Reporting Requirements for Episcopal Churches 2

8 3. Because of liabilities attached to vestries and rectors, consider using a professional payroll service. A payroll service makes tax payments, files tax reports, and produces all year-end paperwork. Using a payroll service places responsibility on a third party to pay your employees on time and relieves the treasurer of producing Forms W-2, Forms 1099, and end-of-year tax reconciliations. Medical Insurance Reimbursement Plan/Employer Payment Plan Internal Revenue Code Section 106 Employer payments and reimbursements of health insurance premiums for group health care coverage provided by the employer to the employee continue to be treated on a tax-favored basis pursuant to Internal Revenue Code ( Code ) Section 106. However, pursuant to guidance issued by the Internal Revenue Service in Notice , in most cases, it is no longer permissible for an employer to directly reimburse an employee for premiums paid by the employee for the purpose of purchasing an individual insurance policy. Further guidance was issued by the Department of Labor on November 6, 2014, which clarified that this type of reimbursement is prohibited, regardless of whether the reimbursement is treated as taxable or non-taxable. Additionally, in Chief Counsel Memorandum , the Internal Revenue Service clarified that an employer may only exclude from an employee s gross income payments for the cost of health insurance coverage provided through the spouse s group health plan if the spouse paid for the coverage on an after-tax basis and not through salary reduction under a cafeteria plan. This rule applies whether or not the employer s payment for such coverage is paid directly to the employee or through a Health Reimbursement Arrangement (HRA). Therefore, before excluding a payment made to your employee for health insurance coverage provided through the spouse s group health plan, the employee must substantiate that the spouse paid for such group health coverage on an after-tax basis. This is an important limitation because most spouses will pay their health premiums on a pre-tax basis (through a Code Section 125 cafeteria plan) and, in fact, some employers require that any premiums be paid this way. 21st Century Cures Act Special HRA Rules for Small Employers On December 7, 2016, Congress passed the 21st Century Cures Act. This Act includes a provision that, effective for plan years after December 31, 2016, exempts HRAs maintained by qualified small employers from the restrictions on the use of HRAs to reimburse premiums for individual coverage. A qualified small employer HRA is: An HRA maintained by an employer with fewer than 50 full-time equivalent employees and that does not offer a group health plan to any of its employees, 3 The 2018 Federal Reporting Requirements for Episcopal Churches

9 Generally provided on the same terms for all eligible employees, Funded solely by employer contributions, and The amount of payments and reimbursements does not exceed $4,950 ($10,000 in the case of an arrangement that also provides for payments or reimbursements for family members of the employee), adjusted for cost-of-living increases. Employers that fund qualified small employer HRAs are subject to certain notice and reporting obligations. Reporting the Value of Health Care Coverage Provided to Non-Dependent Domestic Partners and Their Children and Employees Adult Children Age 26 or Older Health coverage provided to a domestic partner, children of domestic partners who are not the legal children of the employee, and adult children after the calendar year in which they turned 26 (collectively referred to as a Non-Tax Dependent ) is considered a taxable benefit for federal tax purposes and must be reported on the employee s Form W-2 (unless such individual qualifies as a tax dependent). As such, the fair market value of the health coverage provided to a Non-Tax Dependent must be included in the employee s income and applicable income tax and employment tax must be withheld from this imputed income each pay period. The Internal Revenue Service has not issued guidance on how to calculate the fair market value of this health coverage, but the employer should identify a reasonable method to calculate and report the fair market value of health coverage even if there is no incremental cost to cover the Non-Tax Dependent. One way of obtaining this imputed value may be to go to the Health Insurance Marketplace and determine costs for comparable health coverage for the Non-Tax Dependent. Please consult your tax advisor for further information. Example Larry Jones, Jr., an adult child, turns 26 on July 1, His health coverage is provided tax-free through the employer of Larry Jones, Sr., until December 31, Starting January 1, 2018, the value of his health coverage is considered a taxable benefit for federal income tax and employment tax purposes and should be reported as imputed compensation on the Form W-2 issued to Larry Johnson, Sr. Reporting Requirements for 2017 Calendar Year: Employer-Provided Health Insurance Offer and Coverage The reporting requirements consist of the following forms: Providers of minimum essential coverage are required to file Forms 1094-B and 1095-B. These forms are used to report certain information to the The 2018 Federal Reporting Requirements for Episcopal Churches 4

10 IRS and to employees about individuals who are covered by minimum essential coverage and therefore aren t liable for the individual shared responsibility payment penalty. These forms must be filed by February 28, 2018, (April 2, 2018, if filed electronically). The Medical Trust files these forms for members in the Medical Trust Plan. Applicable large employers, generally employers with 50 or more fulltime employees (including full-time equivalent employees) in the previous year, must file one or more Forms 1094-C (including a Form 1094-C designated as the Authoritative Transmittal, whether or not filing multiple Forms 1094-C), and must file a Form 1095-C for each employee who was a full-time employee of the employer for any month of the calendar year. Generally, the employer is required to furnish a copy of the Form 1095-C (or a substitute form) to the employee. These forms must be filed by February 28, 2018, (April 2, 2018, if filed electronically). The information reported on Forms 1094-C and 1095-C is used to determine whether an employer owes a payment under the Employer Shared Responsibility provisions of the Affordable Care Act (ACA) (the employer mandate or play or pay provisions). See the instructions to these forms on the IRS website (irs.gov) for more information. Key Point Churches with fewer than 50 full-time employees and an insured group health plan generally have no reporting obligation. They are not required to file Forms 1094-C and 1095-C since they have fewer than 50 employees, and their group plan insurer files the Forms 1094-B and 1095-B. Key Point If required to prepare the relevant tax forms, the employer must maintain monthly records of its full-time employees (as defined in Code Section 4980H) and certain other information related to the health coverage provided to each full-time employee. Therefore, employers should consult with their tax advisors as soon as possible in order to prepare for these new tax reporting requirements and to avoid potential penalties under the Employer Shared Responsibility provisions. Maximizing Tax Benefits for Your Minister Special Notes for New Clergy When negotiating the contract for a new cleric, make certain that a proper housing allowance resolution has been adopted by the vestry (or other governing body) before compensation is earned. Also when negotiating contracts, arrange for reimbursable expense plans for automobile and other necessary business expenses. 5 The 2018 Federal Reporting Requirements for Episcopal Churches

11 Recommend that the cleric begin saving for retirement through an Internal Revenue Code Section 403(b) salary reduction plan as soon as possible. Be aware that discretionary funds are the property of the church. The cleric must use them only for proper purposes and account to the church for such funds. Make certain that the compensation details have been properly reported to The Church Pension Fund, and the required contributions are being paid pursuant to the Clergy Pension Plan. The employer s failure to pay contributions on time could result in the loss of Active status under the Clergy Pension Plan and the loss of certain benefits (e.g., life insurance and disability benefits). The employer will also be assessed interest on late assessment payments. If you have questions, contact either of the following individuals before taking action: Nancy Fritschner (877) Bill Geisler (877) Special Notes for Churches Pertaining to Current Employees, Including Those Receiving Pensions The pension received by a cleric from the Clergy Pension Plan and distributions from The Episcopal Church Retirement Savings Plan ( RSVP ) sponsored by The Church Pension Fund are designated as housing allowance for federal income tax purposes. To the extent that these amounts were from contributions to the Clergy Pension Plan and the RSVP from earnings generated from ministerial services and are spent for qualified housing expenses for the cleric s primary residence, they may be excluded from taxation, subject to the housing allowance limitations. Earnings from ministerial services after retirement are also eligible for designation as housing allowance. If a cleric s Clergy Pension Plan benefits and withdrawals from an RSVP are enough to cover qualified housing costs, he or she should not request additional housing allowance designation for any compensation for ministerial services. Self-employment tax (SECA) is due on all currently earned income, even if the cleric is retired and collecting Social Security. The cleric should include any currently earned housing allowance and/or the fair rental value of any church-provided housing. Failure by the cleric to include the proper value of such housing could result in additional tax liabilities, plus interest and penalties. If this income is not reported, the statute of limitations on assessing tax adjustments may not apply. No SECA tax is due on qualified pension plan distributions, including the amount excluded as housing. The 2018 Federal Reporting Requirements for Episcopal Churches 6

12 Housing provided to clergy employed for a short time away from home (a short time is generally considered to be a contract for one year or less) can in some cases be treated as a reimbursable business expense and will not be subject to income tax or self-employment tax (SECA). Contracts for an indefinite period, or a specific period of more than one year, would not qualify for such exclusion. Such arrangements could result in moving the cleric s tax home (primary residence) to the interim location. Be very careful about the wording of interim ministry contracts. A part-time cleric has a contract or understanding that states a period of time during which the employee is expected to work for the church. Commuting mileage would not qualify for a tax-free reimbursement. Such a person may qualify for fringe benefits which are tax-exempt and would receive a Form W-2 at the end of the year. Pensions are not earned income and therefore are not subject to selfemployment tax (SECA), with the possible exception of retirement benefits paid from a non-qualified deferred compensation plan. Moving expenses are not deductible unless the cleric is moving at least 50 miles to a new, full-time position. See IRS Form Key Point Tax Cuts and Jobs Act Update The exclusion for qualified moving expense reimbursement has been repealed by the Tax Cuts and Jobs Act for taxable years beginning in Therefore, starting in 2018, the reimbursement of moving expenses to an employee will need to be reported as additional compensation. If a cleric meets the eligibility requirements for active health coverage through his or her employer and is also covered by Medicare, under the Medicare Secondary Payer rules, Medicare will require the employer s active medical coverage to become the cleric s primary medical coverage unless the cleric is employed by an employer who qualifies for the Medicare Secondary Payer Small Employer Exception. The employer is prohibited from excluding employees or their spouses who are age 65 or older from active coverage if they otherwise meet the eligibility requirements. This means that a cleric who is enrolled in Medicare and eligible for employer-provided active health coverage is no longer eligible for the Medical Trust s Medicare Supplement Health Plan or the post-retirement medical subsidy provided by The Church Pension Fund. 7 The 2018 Federal Reporting Requirements for Episcopal Churches

13 It is important that the employer and cleric talk with an Episcopal Church Medical Trust Client Services representative. Failure to comply with the Medicare Secondary Payer rules could result in penalties being assessed against the employer. When a cleric no longer qualifies for active medical coverage, it is important that the cleric contact Medicare and The Episcopal Church Medical Trust Client Services to reactivate proper coverage. This applies to lay employees as well. Be aware of one important Clergy Pension Plan reporting requirement. Some retired clergy who return to work may be considered to have returned to active ministry under the Clergy Pension Plan. To avoid such a determination, which will result in the suspension of pension benefits and re-imposition of pension assessments, retired clergy pursing compensated ministry in the Church should be aware of the Clergy Pension Plan s Working While Pensioned guidelines. A retired cleric under the age of 72 can continue to work for the Church while receiving a pension if he or she earns less than $38,250 in a 12-month period (as of 2018) and works for a different Church employer than the one from which he or she retired. Note that in addition to base salary and bonuses, compensation includes the value of any church-provided housing and cash housing allowance for positions more than 12 months in duration; any housing allowance if the cleric remains in his/her primary residence even if the cleric s tenure is less than 12 months; and all contributions to a Section 403(b) plan. If the cleric s compensation will exceed this limit or if the cleric returns to a position at the same organization from which he/she retired even at compensation below the limit, the bishop (or the Ecclesiastical Authority) of the diocese in which the ministry will be performed must request and receive a Working While Pensioned exception from The Church Pension Fund prior to the commencement of such services. Exceptions are granted for a maximum of two years over a retired cleric s lifetime. For more details, go to and search for Working While Pensioned. There are no Working While Pensioned restrictions once the cleric attains age 72 or for clergy earning compensation from secular work. If you have tax questions, it is always better to call our tax line before taking action. (See tax line information on page 6.) Housing Allowance Caution: The housing allowance is being challenged in federal court as an unconstitutional preference for religion. See the discussion of this case, including its possible impact, in a special section at the beginning of the 2018 Clergy Tax Guide for Episcopal Ministers. The 2018 Federal Reporting Requirements for Episcopal Churches 8

14 The most important tax benefit available to clergy who own or rent their home is the housing allowance exclusion. Unfortunately, many churches fail to designate a portion of their cleric s compensation as a housing allowance, and thereby deprive the cleric of an important tax benefit. A housing allowance is simply a portion of a cleric s compensation that is so designated in advance by the cleric s employing church. For example, in December 2017 a church agrees to pay its cleric total compensation of $45,000 for 2018, and, at the request of the cleric, designates $15,000 of this amount as a housing allowance. This costs the church nothing. It is simply a matter of designating part of a cleric s salary as housing allowance. Code Section 107 specifies that the housing allowance of clergy who own or rent their primary residence is non-taxable in computing federal income taxes to the extent that it: 1. Is declared in advance by resolution of the vestry 2. Is used for qualified housing expenses 3. Does not exceed the fair rental value of the cleric s home, furnished, plus utilities Key Point The housing resolution should ordinarily equal the fair rental value of the clergy-provided housing, furnished, plus estimated utilities. Any excess housing allowance must be reported by the cleric as taxable income on Form Key Point The amount of the housing allowance should not ordinarily be included in the Letter of Agreement. Key Point Note that it is the responsibility of the ordained employee who owns or pays rent for his or her primary residence to determine the fair rental value, furnished, plus utilities of that home; and unless the housing allowance resolution amount suggested by the ordained employee exceeds his or her compensation the employer or vestry should accept and duly approve it. Key Point Under no circumstances can a church designate a housing allowance retroactively. Key Point Although the costs of a mortgage may qualify as part of the housing allowance, costs associated with refinancing a principal residence 9 The 2018 Federal Reporting Requirements for Episcopal Churches

15 or with obtaining a home equity loan qualify only if the proceeds are specifically used for acquiring, improving, or maintaining a principal residence. Clergy who live in rent-free church-provided housing, which is provided as compensation for ministerial services, do not include the annual fair rental value of church-provided housing as income in computing their federal income taxes. The annual fair rental value is not deducted from the cleric s income. Neither is it reported as additional income anywhere on Form W-2. Note, however, that an income tax exclusion that functions much like the clergy housing allowance resolution described above for clergy who own or rent also may be available to clergy in church-provided housing. In this case, the housing allowance resolution amount would NOT be the fair rental value itself but the added value that the cleric s own furnishings bring to the fair rental value of the church-provided housing. Also note that determining these two values (the fair rental value plus the value that personal furnishings add to a fair rental value) is the responsibility of the ordained employee, NOT the employer or vestry. Please note that qualified housing expenses for clergy who own/rent or the fair rental value of rent-free church-provided housing are non-taxable when computing federal income taxes and most though not all state income taxes, but they are taxable when computing self-employment taxes. Clergy who own or rent may NOT exclude housing allowance amounts from income when computing self-employment taxes. Clergy in churchprovided housing MUST include the fair rental value of church-provided housing as income when computing self-employment taxes. Key Point The cash housing allowance approved by the church should be included in the compensation reported to The Church Pension Fund. The church must also report whether housing is provided to the cleric. Key Point Church treasurers should be sure that the designation of a housing allowance for the following tax year is on the agenda of the church for one of its business meetings of the current year. The designation should be an official action, and it should be duly recorded in the minutes of the meeting. The IRS may recognize designations included in employment contracts and budget line items assuming in each case that the church duly adopted the designation in advance but these designations do not comply with Code Section 107 and therefore may not be accepted by the IRS. The 2018 Federal Reporting Requirements for Episcopal Churches 10

16 Key Point Clergy who live in rent-free church-provided housing will NOT be allowed to claim a housing allowance for any other real property that they own while living in rent-free church-provided housing. See below and the next page for two sample housing allowance resolutions from the vestry or other church governing body. Notice the use in both examples of so-called safety-net language ( and all future years unless otherwise provided ). Such language ensures that the previous year s housing allowance figure will be effective in the new year even if the employer neglects to resolve an updated amount. Sample housing allowance resolution for a minister who owns or rents his or her home: The following resolution was duly adopted by the vestry of Christ Church at a regularly scheduled meeting held on December 18, 2017, a quorum being present: Whereas, the Reverend Samuel Johnson is compensated by Christ Church exclusively for the services as a minister of the gospel; and Whereas, Christ Church does not provide Fr. Johnson with a rectory; therefore, it is hereby Resolved, that the total compensation paid to Fr. Johnson for calendar year 2018 shall be $50,000, of which $15,000 is hereby designated to be a housing allowance pursuant to Section 107 of the Internal Revenue Code; and it is further Resolved, that the designation of $15,000 as a housing allowance shall apply to calendar year 2018 and all future years unless otherwise provided. 11 The 2018 Federal Reporting Requirements for Episcopal Churches

17 Sample housing allowance resolution for a minister who lives in a church-provided rectory: The following resolution was duly adopted by the vestry of Grace Church at a regularly scheduled meeting held on December 18, 2017, a quorum being present: Whereas, the Reverend John Smith is compensated by Grace Church exclusively for services as a minister of the gospel; and Whereas, Grace Church provides Fr. Smith with rent-free use of a church-provided rectory as compensation for services that he renders to the church in the exercise of his ministry; and Whereas, Fr. Smith incurs expenses for living in church-provided housing; therefore it is hereby Resolved, that the annual compensation paid to Fr. Smith for calendar year 2018 shall be $50,000, of which $5,000 is hereby designated to be a housing allowance pursuant to Section 107 of the Internal Revenue Code, and it is further Resolved, that the designation of $5,000 as a housing allowance shall apply to calendar year 2018 and all future years unless otherwise provided by the vestry; and it is further Resolved, that as additional compensation to Fr. Smith for calendar year 2018 and for all future years unless otherwise provided for by this vestry, Fr. Smith shall be permitted to live in the church-provided rectory located at 123 Main Street, and that no rent or other fee shall be payable by Fr. Smith for such occupancy and use. Accountable Reimbursements The best way for employees to handle their church-related business expenses is to have their employing church adopt an accountable business expense reimbursement arrangement. An accountable business expense reimbursement arrangement is one that meets the following four requirements: 1. Only business expenses are reimbursed. 2. No reimbursement is made without an adequate accounting of expenses within a reasonable period of time (not more than 60 days after an expense is incurred). 3. Any excess reimbursement or allowance must be returned to the employer within a reasonable period of time (not more than 120 days after an excess reimbursement is paid). The 2018 Federal Reporting Requirements for Episcopal Churches 12

18 4. An employer s reimbursements must come out of the employer s funds and not by reducing the employee s salary. Under an accountable plan, reimbursements of business expenses are not reported as taxable income on the employee s Form W-2 or Form 1040, and there are no deductions for the employee to claim. In effect, the employee is reporting to the church rather than to the IRS. Such a plan which translates into significant tax savings for the employee is the best way for a church and an employee to handle reimbursements of business expenses. An accountable business expense reimbursement arrangement should be established by the vestry in an appropriate resolution. Churches occasionally reimburse employees for non-business expenses. Such reimbursements, though they require an accounting, ordinarily must be included in the employee s wages for income tax reporting purposes, and they are not deductible by the employee. Such personal, living, or family expenses are not deductible, and the entire amount of a church s reimbursement must be included on the employee s Form W-2 and Form Qualified Transportation Fringe Benefits The exclusion for employer-provided reimbursement for van-pooling, mass transit passes and qualified parking was $255 per month for 2017 and becomes $260 for The exclusion for qualified bicycle commuting costs was $20 per month in 2017 and has been eliminated for Key Point Tax Cuts and Jobs Act Update Beginning in 2018, a tax-exempt organization s unrelated business taxable income ( UBTI ) will be increased by the amount the organization pays or incurs for qualified transportation fringe benefits, whether they are paid as an employer-funded benefit or appears through employee pre-tax salary deductions. As such, providing this benefit to your employees may result in an unrelated business income tax ( UBIT ) filing obligation on a Form 990-T and a liability for UBIT, which should be considered as an additional cost when planning for 2018 expenses. Although some employers may wish to stop offering this benefit as a result of this change in the law, please consult with your legal counsel as some cities mandate that certain employers offer to their employees a commuter benefits program (such as New York City s Affordable Transit Act and similar laws in Washington D.C. and the Bay Area in California). 13 The 2018 Federal Reporting Requirements for Episcopal Churches

19 Flexible Spending Accounts (FSAs) A church or employing organization may set up a flexible spending account for ministers and lay employees. A flexible spending account utilizes a salary reduction agreement for the purpose of reimbursing ministers and lay employees for certain health care and dependent care expenses, subject to reimbursement maximums and other conditions. Code Section 125 allows salary reductions for a flexible spending account if the following conditions are met: 1. The salary reduction is established in advance (this is interpreted to mean prior to both the compensation and the expense). 2. Reimbursement is made only when a bona fide expense has been incurred by the participant. 3. The participant agrees to forfeit any unused balance in the account at the end of the plan year (however, see the grace period that applies to Health FSAs below). 4. The plan must be properly structured (contact a CPA or attorney experienced in such programs) and formally adopted by the vestry. Health Flexible Spending Accounts (Health FSAs) Health FSAs have several benefits, including the following: Employer contributions can be non-taxable. No income taxes or payroll taxes are deducted from employee contributions. Amounts used for qualified medical expenses may be tax-free. Employees can withdraw funds from a Health FSA to pay qualified medical expenses even if they have not yet placed the funds in the account. Generally, distributions from a Health FSA must be paid to reimburse the employee for qualified medical expenses. See IRS Publication 502 for a list of qualified medical expenses. Qualified medical expenses are those incurred by an employee or the employee s spouse and certain dependents (including a child under age 27 at the end of the year). To date, employees must be able to receive the total amount they have elected to contribute for the year at any time during the year, regardless of the amount they have actually contributed. Health FSAs are use-it-or-lose-it plans. This means that amounts in the account at the end of the plan year cannot be carried over to the next year. The 2018 Federal Reporting Requirements for Episcopal Churches 14

20 However, the plan can provide for a grace period of up to 2½ months after the end of the plan year. If the plan provides for a grace period, any qualified medical expenses incurred in that grace period can be paid from any amounts left in the account at the end of the previous year. An employer is not permitted to refund any part of the Health FSA balance to the employee. Key Point An employer, at its discretion, may amend its cafeteria plan document to provide for the carryover to the next plan year any amount (up to $500) remaining unused as of the end of the plan year in a Health FSA. The carryover of up to $500 may be used to pay or reimburse qualified medical expenses under the Health FSA incurred during the entire plan year to which it is carried over. For this purpose, the amount remaining unused as of the end of the plan year is the amount unused after medical expenses have been reimbursed at the end of the plan s run-out period for the plan year. In addition to the unused amounts of up to $500 that a plan may permit an individual to carry over to the next year, the plan may permit the individual to also elect up to the maximum allowed salary reduction amount ($2,600 for 2017 and $2,650 for 2018). Thus, the carryover of up to $500 does not count against or otherwise affect the $2,600/$2,650 salary reduction limit applicable to each plan year. Although the maximum unused amount allowed to be carried over in any plan year is $500, the plan may specify a lower amount as the permissible maximum (and the plan sponsor has the option of not permitting any carryover at all). Key Point A plan adopting this carryover provision is not permitted to also provide a grace period with respect to Health FSAs. The maximum amount available for reimbursement of incurred qualified medical expenses of an employee and the employee s dependents under a Health FSA cannot exceed $2,650 for Note that the Affordable Care Act prohibits employers from using a Health FSA to pay for, or reimburse, the cost of individually owned health insurance policies with pre-tax dollars. An employee covered by an HDHP and a Health FSA or an HRA that pays or reimburses qualified medical expenses generally can t make contributions to an HSA. See IRS Publication 969 for more detailed information. Dependent Care Flexible Spending Accounts (Dependent Care FSAs) Dependent Care FSAs can also be established to pay for certain expenses to care for eligible dependents. While this type of plan generally covers expenses related to child care of children up to age 13, it can also be used 15 The 2018 Federal Reporting Requirements for Episcopal Churches

21 for children of any age who are physically or mentally incapable of selfcare, as well as adult day care for senior citizen dependents who live with the person, such as parents or grandparents. Additionally, the person or persons on whom the dependent care funds are spent must be able to be claimed as a dependent on the employee s federal tax return. The funds cannot be used for summer camps (other than day camps ) or for longterm care for parents who live elsewhere (such as in a nursing home). The Dependent Care FSA is federally capped at $5,000 per year, per household. Married spouses can each elect an FSA, but their total combined elections cannot exceed $5,000. At tax time, all withdrawals in excess of $5,000 are taxed. If married, both spouses must have earned taxable income to be eligible to participate in a Dependent Care FSA. Unlike Health FSAs, Dependent Care FSAs are not pre-funded ; employees cannot receive reimbursement for the full amount of the annual contribution on day one. Employees can only be reimbursed up to the amount they have contributed during that plan year. Section 403(b) Plans A Section 403(b) plan, such as The Episcopal Church Retirement Savings Plan ( RSVP ), is a retirement plan for certain employees of churches and other tax-exempt organizations. These plans have the following tax benefits: 1. Employees do not pay income tax on pre-tax amounts contributed until they begin taking withdrawals from the plan, usually after they retire. Note, however, that Social Security and Medicare taxes are due on all contributions to a Section 403(b) plan for lay employees. 2. Earnings and gains on pre-tax contributions to an employee s Section 403(b) account are not taxed until they are withdrawn, unless such distributions otherwise qualify for a housing allowance exclusion. 3. Employees may be eligible to claim the retirement savings contributions credit ( saver s credit ) for elective deferrals contributed to a Section 403(b) account. (See IRS Publication 590-A for more information.) There are limits on the amount of contributions that can be made to a Section 403(b) account each year. For 2017, the maximum combined contribution (i.e., employer contributions and salary deferrals) is the lesser of 100% of taxable compensation or $54,000 ($60,000 for those age 50 or older). The maximum pre-tax salary deferral for 2017 is $18,000 (or $24,000 for those age 50 or older). For 2018, the maximum combined contribution (i.e., employer contributions and salary deferrals) is the lesser of 100% of taxable compensation or $55,000 ($61,000 for those age 50 or older). The maximum pre-tax The 2018 Federal Reporting Requirements for Episcopal Churches 16

22 salary deferral for 2018 is $18,500 (or $24,500 for those age 50 or older). If contributions made to a Section 403(b) account are more than these contribution limits, penalties may apply. Generally, annual contributions to a Section 403(b) plan cannot exceed either the limit on annual additions or the limit on elective deferrals. See IRS Publication 571 for details. Warning Deferred compensation not placed into a Section 403(b) plan or other qualified plan may be subject to Code Section 409A. Failure to comply with Code Section 409A may result in significant tax consequences. Please consult a tax professional. Complying with Federal Payroll Tax Reporting Obligations Step 1. Obtain an employer identification number (EIN) from the federal government if this has not been done. This number must appear on some of the returns listed below. It is used to reconcile a church s deposits of withheld taxes with the Forms W-2 issued to employees. The EIN is a nine-digit number that looks like this: If your church does not have an EIN, you may apply for one online. Go to the IRS website at and click on the Apply for an EIN link. You may also apply for an EIN by calling (800) , or you may fax or mail Form SS-4 to the IRS. You should have only one EIN. Key Point The employer identification number is not a tax exemption number and has no relation to your non-profit status. It merely identifies the organization as an employer subject to tax withholding and reporting and ensures that your church receives proper credit for payments of withheld taxes. Step 2. Determine whether each church worker is an employee or self-employed. In some cases, it is difficult to determine whether a particular worker is an employee or is self-employed. If in doubt, churches always should treat a worker as an employee, since substantial penalties can be assessed against a church for treating a worker as self-employed whom the IRS later reclassifies as an employee. In general, a self-employed worker is one who is not subject to the control of an employer with respect to how a job is to be done. Further, a self-employed person typically is engaged in a specific trade or business and offers his or her services to the general public. The IRS has developed several criteria to assist in classifying a worker as an employee or self-employed. Factors that tend to indicate employee status include the following: 17 The 2018 Federal Reporting Requirements for Episcopal Churches

23 The worker is required to follow an employer s instructions regarding when, where, and how to work. The worker receives on-the-job training from an experienced employee. The worker is expected to perform the services personally, and not use a substitute. The employer rather than the worker hires and pays any assistants. The worker has a continuing working relationship with the employer. The worker receives a regular wage amount for an hourly, weekly, or other period of time, regardless of whether they are full-time or part-time. The work is done on the employer s premises. The worker must submit regular oral or written reports to the employer. The worker s business expenses are reimbursed by the employer. The employer furnishes the worker s tools, supplies, and equipment. The worker does not work for other employers. The worker does not advertise his or her services to the general public. Not all of these factors must be present for a worker to be an employee. But if most of them apply, the worker is an employee. In addition, the Department of Labor issued Administrator s Interpretation No which strengthens the government s definition of employee and narrows the definition of independent contractor even further. Once again: if in doubt, treat the worker as an employee. Warning The IRS and other governmental agencies are becoming much more aggressive in classifying workers as employees. Improper classification can result in significant back taxes and penalties. Key Point For 2018, churches must withhold 24% of the compensation paid to a self-employed person who fails to provide his or her Social Security number to the church. This is referred to as backup withholding and is designed to promote the reporting of taxable income. Key Point A cleric who is receiving employer-provided fringe benefits must be considered an employee and receive a Form W-2. Common examples are group medical insurance and flexible savings accounts. Fringe benefits are non-taxable only when received by employees. The 2018 Federal Reporting Requirements for Episcopal Churches 18

24 Warning Effective January 1, 2018, the church is required to pay pension assessments to The Church Pension Fund, whether or not the cleric is classified as an employee or independent contractor, if a cleric is regularly employed for 5+ consecutive months and is compensated. Note that compensation will include employer-provided housing even if no salary is paid to the cleric. A cleric is considered regularly employed if he or she meets one or more of the following: Has a letter of agreement or contract of employment, OR Is duly called by bishop, vestry or rector, OR Has a formal title indicating substantial ongoing relationship, OR Is issued Form W-2, OR Is scheduled to work 20+ hours per week Participation in the plan is optional if a cleric who is working for less than five months has a letter of agreement directing that assessments be paid for his or her services. If the cleric is regarded as self-employed, these payments would normally be included in the compensation reported on Form If, instead, the cleric is classified as an employee who receives a Form W-2, the employer will not have to report the paid assessments as additional income. Step 3. Obtain the Social Security number of each worker. After determining whether a worker is an employee or self-employed, you must obtain the worker s Social Security number. A worker who does not have a Social Security number can obtain one by filing Form SS-5. If a self-employed worker performs services for your church (and earns at least $600 for the calendar year) but fails to provide you with his or her Social Security number, then the church is required by law to withhold a specified percentage of compensation as backup withholding. The backup withholding rate is 24% for Of course, a self-employed person can stop backup withholding by providing the church with a correct Social Security number. The church will need the correct number to complete the worker s Form 1099-MISC (discussed later). Churches can be penalized if the Social Security number they report on a Form 1099-MISC is incorrect, unless they have exercised due diligence. A church will be deemed to have exercised due diligence if it has required self-employed persons to provide their Social Security numbers using Form W-9. As a result, it is a good idea for churches 19 The 2018 Federal Reporting Requirements for Episcopal Churches

25 to present self-employed workers (e.g., guest speakers, contract laborers) with a Form W-9, and then to withhold 24% of total compensation for 2018 as backup withholding unless the worker returns the form. The church should retain each Form W-9 to demonstrate its due diligence. All taxes withheld through backup withholding must be reported to the IRS on Form 945. The Form 945 for 2017 must be filed with the IRS by January 31, However, if you made deposits on time in full payment of the taxes for the year, you may file the return by February 12, Step 4. Have each employee complete a Form W-4. These forms are used by employees to claim withholding allowances. A church will need to know how many withholding allowances are claimed by each lay employee in order to withhold the correct amount of federal income tax. A withholding allowance lowers the amount of federal income tax that will be withheld from an employee s wages. Require that all new employees give you a signed Form W-4 when they start work. If an employee does not complete such a form, then the church must treat the employee as a single person without any withholding allowances or exemptions. Employers must put into effect any Form W-4 that replaces an existing certificate no later than the start of the first payroll period ending on or after the 30th day after the day on which the replacement Form W-4 is received. Of course, you can put a Form W-4 into effect sooner, if you wish. Employers are not responsible for verifying the withholding allowances that employees claim. Although withholding of income tax is not required for clergy, they nonetheless should complete page 1 of Form W-4 with their employers as this information may be necessary when issuing Form W-2; this form also allows clergy to indicate any voluntary federal income tax withholding requested. Key Point Tax Cuts and Jobs Act Update The Internal Revenue Service has recently issued Notice This notice reflects the federal income tax withholding changes made pursuant to the recently enacted Tax Cuts and Jobs Act. As stated in the notice employers should implement the 2018 withholding tables as soon as possible, but not later than February 15, The IRS emphasizes that the new federal income tax withholding tables are designed to work with the existing Form W-4 that employees have already filed, and no further action by employees is needed at this time. However, you may want to recommend that employees review their Form W-4 and update if necessary. The 2018 Federal Reporting Requirements for Episcopal Churches 20